There are still three weeks left until the last interest rate meeting this year. Although Federal Reserve officials have repeatedly signaled that they will patiently wait for more evidence to show that inflation is cooling down, investors have become more optimistic. Interest rate futures indicate that the possibility of the Federal Reserve continuing to raise interest rates has been ruled out, and investors are concerned about the possibility of a rate cut as early as May next year.
The easing of financial conditions has become more evident with the decline in long-term US bond yields. For the Federal Reserve, which is concerned about policy two-way risks, how to "brake" market enthusiasm may become a challenge.
Expected increase in soft landing
At the beginning of this month, the Federal Reserve decided to keep the federal funds rate at its highest level in nearly 22 years for the second time in a row.
The resolution statement implies that if inflation does not continue to slow down, it will open the door to further interest rate hikes in the future. This means that the Federal Reserve will continue to determine whether further action is needed based on data at subsequent meetings.
According to Federal Reserve Chairman Powell, reducing inflation may require below-trend economic growth and a softening of job market conditions. Now the data seems to be moving in the direction he envisions. The labor market seems to have finally started to loosen. The United States added 150000 new jobs last month, setting a new low in nearly two and a half years. The unemployment rate rebounded to 3.9%, and the number of initial claims for unemployment benefits rebounded to a three-month high.
As an important component of consumer spending, retail sales in the United States fell by 0.1% last month, marking the first decline since April this year. At the same time, the expansion of the service industry is also approaching a critical point. According to ISM data from the American Supply Association, non manufacturing PMI in the United States has slowed to a five month low. The Atlanta Fed's GDPNow tool shows that the US economy grew at 2.0% in the fourth quarter, a significant slowdown from 4.9% in the third quarter.
This also raises expectations that the Federal Reserve will end interest rate hikes. Affected by this, the US dollar index, which has shown strong performance since the beginning of this year, has basically given up its gains, with a cumulative decline of nearly 3% since November, marking the largest monthly decline in nearly a year. Oanda Senior Market Analyst Craig Erlam said in an interview with First Financial reporters that from the perspective of anti inflation trends and economic cooling, the policy effect of this round of interest rate hikes has finally begun to show, and the reason for the Federal Reserve to continue to be patient is becoming increasingly strong.
The prospects for a soft landing have become optimistic. A survey by the American Association of Business Economists (NABE) shows that 70% of economists say there will be no recession next year.
Goldman Sachs believes that the likelihood of an economic recession in the next 12 months is 15%, and it is expected that the gross domestic product will grow by 2.1% in 2024. The conditions for inflation to return to its target have been met, and the heaviest blow from monetary and fiscal tightening has passed, "the report said.
How does the Federal Reserve respond to calls for interest rate cuts
Federal funds rate futures show that while betting on the Fed to end rate hikes, investors have turned their attention to rate cuts. The latest pricing shows that the probability of a rate cut in May next year is over 50%, and the probability of a rate cut in June is over 80%.
Institutions are also eager to try policy inflection points. Morgan Stanley believes that the Federal Reserve will cut interest rates by 25 basis points for the first time in June 2024, four times throughout the year, and every meeting in 2025. Bank of America also expects the Federal Reserve to start cutting interest rates in June next year, followed by quarterly rate cuts.
It is worth noting that, compared to the optimism from the outside world, the Federal Reserve has not made any substantive statements on the issue of interest rate cuts so far. Powell has also repeatedly suppressed speculation in the past two years, with the most recent example being this month's group discussion at the International Monetary Fund (IMF). He stated that sustained progress towards achieving the 2% target is uncertain, and inflation data may sometimes have false appearances.
On the 21st local time, the Federal Reserve will release the minutes of last month's interest rate meeting, and the outside world will focus on the details of policy decision discussions, especially the threshold for potential interest rate hikes.
Erram told First Financial that he believes the minutes will show that the Federal Reserve continues to emphasize inflation risks and mentions potential interest rate hikes. For the Federal Reserve, prices cannot be taken lightly, core inflation remains near 4%, and from the perspective of rent and service price trends, it may be difficult to fall back below 3% in the first half of the year. Even if there are no further interest rate hikes, the Federal Reserve still needs to keep interest rates high for a period of time and patiently wait for inflation to further advance towards the medium-term target of 2%, which means that the Federal Open Market Committee is still far from announcing its ultimate victory, "he told reporters.
From the recent statements of several officials, it seems that the Federal Reserve has seen changes in market expectations. Boston Fed Chairman Collins stated last week that the Federal Reserve must be patient and decisive, and will not abandon the option of raising interest rates. The key is to truly persevere to the end.
The pricing of expected interest rate cuts has led to a significant decline in mid to long term US Treasury yields since the beginning of this month. The benchmark 10-year US Treasury bond fell below the 4.50% mark, falling more than 60 basis points from its high at the beginning of the month. This also reflects to some extent the relaxation of financial conditions, and behind the recent stock market rebound driven by improved risk appetite is the expectation of improved liquidity. For the Federal Reserve, policy risk may shift to insufficient intensity, resulting in repeated inflation.
Bob Schwartz, a senior economist at the Oxford Institute of Economics, previously stated in an interview with First Financial reporters that the main policy risk for the Federal Reserve in the future remains interest rate hikes, and officials' warning is to avoid the outside world setting policy paths ahead of schedule at the end of the interest rate hike cycle. He believes that the market's expectations for next year's interest rate cut are too optimistic.